This is the first of a series of reports looking at yield that comes from the most tax efficient sources. After all, the saying goes, it is not what you make, it is what you keep.

Asset location is very important when constructing a portfolio. In an ideal world, we would place our equities, munis and other favorably taxed funds into our non-qualified bucket while placing our bonds and other securities that pay taxable interest at ordinary income into our qualified buckets.

Some investments pay what is called a qualified dividend. A qualified dividend must be issued by a U.S. corporation, or by a foreign corporate that readily trades on a major U.S. exchange. In addition, the shares must be held for more than 60 days of the "holding period" before the ex-dividend date.

Dividendinvestor.com has a good summary of the differences between a qualified and ordinary dividend. You can read more (HERE)

On that last item:

Special holding rule requirements apply in order for a dividend to receive favorable tax treatment. For common stock, a share must be held more than 60 days during the 121-day period beginning 60 days before the ex-dividend date. Under IRS guidelines, the ex-dividend date is the date after the dividend has been paid and processed and any new buyers would be eligible for future dividends. For preferred stock, the holding period is more than 90 days during the 181-day period beginning 90 days before the stock’s ex-dividend date.

The tax rates are far lower for qualified dividends:

More detailed for specific income thresholds and filing methods:

Closed-End Funds

Many closed-end funds pay qualified distributions on a portion or in some cases all of their annual dividends. We went through and sorted funds by the amount of qualified dividend income ("QDI") that they paid in the last year and the last three years.

It obviously makes sense to hold these in the non-qualified bucket given the favorable tax treatment though individual circumstances may be different. In most cases, investors have 'limited' space available in their IRAs and tax deferred accounts. Thus, it makes sense to carry the most tax inefficient securities in those accounts.

Most of the top funds on the list are master limited partnership ("MLP") funds, preferred stock funds, and some tax advantaged global equity funds. On the latter, one of the criteria for portfolio managers selecting securities is to find opportunities in stocks that pay that qualified dividend. I'm a little hesitant on those funds simply because the qualified dividend universe is not that large so they are limiting their opportunity set. Second, the holding period may be restricting them from selling in order to reach that 60-day time threshold.

Highest QDI -Most Tax Efficient

Below are the top funds sorted by one-year QDI down to 50%. In other words, these are the funds that paid at least 50% QDI in the last year. The second column shows the 3-year percentage when available.

15 Deepest Discount

These are the 15 deepest discounted funds with QDI above 50%.

15 Highest Yielding

These are the top 15 funds with QDI above 50% sorted by total yield (total distribution yield may include short-term gains, long-term gains, and return of capital).

15 Lowest Z-Score

These are funds with QDI greater than 50% and then sorted by the lowest one-year z-score.

15 Best Total Score

We ranked the funds using a scoring methodology to account for QDI percentage, total yield, discount, and z-score. This is the top 15 funds in descending order by that score.

The fund is a global equity fund that focuses on dividend payers of common and preferred stocks that distribute a high amount of dividend income that qualifies for favorable tax treatment. They use a value investment philosophy with an emphasis on stocks that have the potential for meaningful dividend growth. The current distribution yield is 8.32% with the fund levered up by 23% and has a 47% of holdings in U.S. stocks with the rest of the allocation broken down as follows:

The fund is compared to the MSCI World Index.

For those that dislike similar fund strategies that then use options on top to increase yield, this is one of the funds that does not do that.

The fund pays a managed distribution that is currently set to $0.1025 per share per month. Given the fund does not utilize options to increase yield, in order to achieve the 8.3% distribution yield, paid monthly, they will have to dip into basis (return of capital). The distribution has been unchanged since January 2009.

The below table from CEFConnect shows the breakdown of the distribution which tends to variate in the mix of income, gains, and return of capital. Obviously a portfolio made up of stocks that generate an approximate 2-2.25% yield (before leverage), cannot pay out over 8% and not cannabalize its NAV.

The leverage makes this fund highly volatile, especially when combined with no options overlay that tends to mitigate some of the extreme movement. In 2018, the fund was down 12.87% on NAV, about 2.5x the market. But in 2017, the fund was up nearly 25% on NAV. Longer-term, the 10-year return shows a 12.8% price and a 11.2% NAV annualized total return.

The top ten holdings are below:

The discount over the last three years has been highly variable. A good rule of thumb would be to buy at a 11-12% discount to NAV and sell when it's tighter than a 6% discount.

Characteristics:

Total Net Assets = $1.66B

Dividend Frequency= Monthly

Current Monthly Distribution= $0.1025 per share ($1.23 annually)

Baseline Expense ratio= 1.21% (without leverage costs)

Discount to NAV= -9.16

1-Year Avg. Discount= -6.24%

Leverage= 23.53%

Average 3 Mos. Daily Trading Volume= 184K shares

Approximately 15% of the shares are held by institutional holders with the top five being Morgan Stanley, Bank of America, UBS Group, Advisors Assets Management, and Wells Fargo.

Concluding Thoughts

ETG is a fairly plain-vanilla levered equity fund invested in typical large-cap growth names like Microsoft, Google, Johnson & Johnson, and ExxonMobil. Most of the competition in this space utilize options to juice yield but in some cases, that can also increase risk. ETG employs a managed distribution policy so we must monitor ROC closely to stay ahead of a potential distribution decrease.

ROC over the last three months is 34% based on 19a filings with the SEC. That is up significantly from the approximately 8.62% over the last twelve months. Please remember that ROC is not necessarily a massive red flag and could be due to portfolio changes made (especially given the volatility in the fourth quarter) and/or from GAAP accounting practices on CEFs.

We do believe some destructive ROC is apparent due to the fund losing 3.3% of value on NAV in the last three months. This is something that does bear watching. The current discount "opportunity" at 9.16% could reflect that possibility when compared to the 52-week average of 6.24%.

For those that own EV Tax Advantaged Global Div Opps (ETO), which is a sister fund to ETG, we would recommend looking at switching to ETG. The fund's have performed the same over the last year but there's a 8.50% difference in the discount with ETO trading just under par. The main difference being the distribution yield of ETO being 1.75% higher but that is primarily being driven by the fund paying out long-term capital gains.